Which metric measures how far a portfolio's returns diverge from its benchmark, on average?

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Multiple Choice

Which metric measures how far a portfolio's returns diverge from its benchmark, on average?

Tracking error measures how far a portfolio's returns diverge from its benchmark on average. It is calculated as the standard deviation of the differences between the portfolio’s returns and the benchmark’s returns over a chosen period, showing how consistently the portfolio tracks the benchmark. A small tracking error implies close replication; a larger tracking error indicates more deviation due to active management. Beta, in contrast, gauges market sensitivity rather than actual return differences. Value at Risk estimates potential losses at a given confidence level, not divergence from a benchmark. Downside risk focuses on negative returns below a threshold, ignoring overall relative return dispersion.

Tracking error measures how far a portfolio's returns diverge from its benchmark on average. It is calculated as the standard deviation of the differences between the portfolio’s returns and the benchmark’s returns over a chosen period, showing how consistently the portfolio tracks the benchmark. A small tracking error implies close replication; a larger tracking error indicates more deviation due to active management. Beta, in contrast, gauges market sensitivity rather than actual return differences. Value at Risk estimates potential losses at a given confidence level, not divergence from a benchmark. Downside risk focuses on negative returns below a threshold, ignoring overall relative return dispersion.

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